Any business entity requires proper management to avoid situations that would lead to its imminent collapse and eventually, loss of investment. For this reason, business owners should be very cautious when decided on the auditing firms to examine their books of accounts.
A lot of business enterprises have collapsed due to poor management, inexperienced leaders, or because of incompetent auditors. In this case, when auditors malfunction while carrying out their duties, this greatly affects the operations of an enterprise. For this reason, there is need to ensure that auditors execute their duties efficiently to avoid compromising the operation of an enterprise.
Auditing is a critical activity in the operations of a business entity. In the past, poor performance by auditors has led to the collapse of many businesses. Auditors are charged with the responsibility of undertaking the auditing activities of a company.
According to Apostolon and Crumbley (2008, para. 1), audit is an independent examination of the accounts of the enterprise by an independent auditor. For an auditor to successfully undertake their duties, he or she needs to be familiar with the internal control systems of an enterprise. The auditor should ensure that the internal control systems are strong enough to guarantee fair running of the business.
These controls should avoid overriding of such a system to earn a favor. Internal control failures have led to the collapse of many businesses. In this case, Shearman and Sterling (2009, p.2) highlights the case of a company that was penalized as a result of deficits in the internal control systems in one of its subsidiary called ACL Technologies. According to the partnership, the internal control failures included the following:
Inadequate financial controls
The internal control systems at the firm in question were so poor such that executives were allowed to make large payments to agents without proper authorization. It is important to note that internal controls should not give executives exceptional rights to deal with the resources of an enterprise at their own wish. There should be a maximum amount of resources that the executives should be allowed to exercise. Any amount beyond the stated maximum should be authorized by the right authority.
The services which were allegedly provided by the agent were not properly documented. The internal control systems with respect to recording and documentation were weak. This led to non documentation of the services which the agent purported to have rendered to the subsidiary. This created a leeway for defrauding the company by inflating the cash payable to the agent.
Lack of due diligence
The agent failed to observe his work carefully. He engaged himself in careless dealings which led to the organization operating at a loss. On the other hand, the organization failed to establish adequate internal control systems that would have overseen the activities of the agent. If the subsidiary had established a strong internal control system, then the company would have learnt of the danger earlier.
Lack of audit rights
There was lack of audit rights on the contract with the agent. The subsidiary engaged in contracts with the agent without audit rights. In 1996, the ACL Technologies, Inc, a firm based in California, sought to secure a contract to construct Egyptian Air Force’s aircrafts. In 1999, The Egyptian Air Force (EAF) was sought for a sole source contract from the United States Air Force (USAF).
This would have helped to secure the contract to build the F-depot to ACL Technologies. Afterwards, the United States Air Force awarded the contract to the ACL. In the years that followed, the ACL sought and secured another contract. Between the years 1999 and 2004, the contracts that ACL had secured generated U.S dollars 64 million in revenue and U.S dollars 8.6 million in net profit for ACL.
The allegations by the Security and Exchange Commission’s (SEC) focuses on the payments related to a specific contract. The ACL managed to secure the contract in April, 2002. The Egyptian military employees would then train with the ACL to effectively start their operations on the F-16 depot. According to statistics, the contract generated revenue amounting to U.S $5.3 million and a net profit of U.S $267,000.
The Security and Exchange Commission detailed a series of communications between the Egyptian Air Force Agent and Thomas Wurzel, the then president of ACL. According to the case, communications started back in 2001. The case outlines efforts made to raise funds. These funds were to be used to motivate, secure team loyalty and the business, and satisfy people. In addition, SEC detailed a number of ways that ACL used to cover payments within invoices.
In the year 2009, the SEC announced the filing of settled enforcement action against Wurzel who neither admitted nor denied allegations against him. Wurzel agreed to comply with the orders issued by the SEC, keeping him away from any future violations. He was forced to pay a fine amounting to US $ 35,000. This was termed as a civil penalty. The UIC neither admitted, nor denied these allegations. The Commission ordered the UIC body to keep away from any future violations (Beasley, 2010, para. 4).
According to Apostolon and Crumbles (2008, p.1-2), all companies trading their shares in the capital markets should prepare and present true and fair financial statements. Consequently, the auditors should evaluate these statements along with their corresponding accounts to evaluate whether they represent the true position of the enterprise at the year end.
One of the policies that govern SEC dictates that any corporation that has its shares publicly traded must go through an independent assessment which is conducted by competent audit professionals. The process would involve the inspection of all financial records and other related details. This is aimed at establishing the company’s cash flow which automatically depicts the financial position of the organization.
The GAAOP CPA Journal forms the basis of the operation (2008, para.1). At the end of the inspection, the auditor must comment on the outcomes of the examination. The auditor has the mandate of organizing and conducting the audit work in such a way that the end results reveals whether there are any misrepresentations of financial statements due to fraud or errors.
In addition, Au section 110 (2010, p.6-10) states that the independent auditor also has a responsibility that covers the profession. The American Institute of Certified Public Accounts has rules and standards that stipulate the code of professional ethics. According to AICPA, an auditor must conform to the standards that govern his fellow practitioners.
It is important for auditors and the management to prevent and detect cases of fraud when they arise in the organization. Fraud is a deliberate misrepresentation that causes another person, organization or a group of persons to suffer damages (Pollick, 2010, para. 1), usually monetary losses. The high level of fraud has made many investors to suffer huge losses. The high level of fraud has remained persistent due to the complexity of detecting fraud using the current available technologies.
To avoid such losses, the auditor should include in his report disclaimers warning the investors that the accounts are not prepared in accordance with the Generally Accepted Accounting Principles. Therefore, when the auditor is expressing his/her opinions, he/she should bear take into account the plight of the users of the audited financial statements to avoid instances of a legal suit.
Conclusion-Internal control failures
In conclusion, UIC lacked meaningful controls to prevent or detect the ACL president’s authorization of unwarranted payments to the agent. To support the conclusion, the Security and Exchange Commission highlighted a series of UIC’s internal control failures which included:
- Front end accounting controls
- Back end accounting controls
- Due diligence on agents and
- Contractual rights.
With regard to the front-end accounting controls, no single person is allowed to authorize transactions or payments without sufficient internal transparency. This is made possible through separation of duties. In this case, SEC alleged that the CIU had permitted the president, Wurzel, to allow huge payments to the EAF Agent without substantiated documents.
In addition, the Security and Exchange Commission was aware of one occasion in which a UIC official did review a payment. There was an unusual US $ 100,000 advance to the Egyptian Air Force Agent. The SEC had also realized that one of the UIC employees approved the payment without inquiring into the purpose or a justification for the payment.
Secondly, there was back end accounting controls. According to Shearman and Sterling (2008, p.2), the Accounting 101 requires that all payments should be supported by proper documents. The substantiated documents should prove that payments are for certifiable goods or services. According to SEC, the ACL is supposed to pay the EAF agent up to U.S. $ 564,000.
This is the estimated amount of money charged for marketing and consulting services. The amounts paid in respect to the services rendered hardly had no meaningful records documenting the services that the Egyptian Air Force Agent had allegedly provided to the CIU.
Moreover, it was clear that the ACL Company had been making transactions with the EAF Agent for up to six months yet there were no written records. Thirdly, there was lack of due diligence on the part of the agents. According to the accounting compliance (Compliance 101), companies are very much obliged to conduct the elements of due diligence to foreign consultants and to agents as well.
With regard to the case study in question, the SEC reveals that there was a UIC’s policy which stipulated that all people who wished to be foreign agents surrender their outstanding diligence forms. In the case of the Egyptian Air Force Agent, ACL first began paying the Egyptian Air Force Agent in the year 1997 without having executed a contract. In March 1998, the Egyptian Air Force agent implemented the contract. However, the agent overlooked any due diligence.
In addition, the CIU Company obtained in the year 1999 a corporate legal approval of the contact. Even then, the CIU did not submit any evidence of having conducted due diligence beforehand. Those who needed the diligence forms in 1992 did not go through an independent judgment because ACL forwarded the forms that the EAF agent had filled. In conclusion, there was an internal control deficit on contractual rights.
The Accounting Compliance 101 dictates that after companies are engaged, it’s upon the companies to examine and supervise what the agents carry out. SAC agents become part of the company. Agency contracts should conduct maximum monitoring as expected. Although the UIC realizes about the case early enough, there was need for the agency contracts to include warranties and certification apart from just the standardized FCPA representations.
The auditors and accounts would also be allowed to access consultant’s books and records. On the other hand, SEC realized that the UIC’S corporate legal agreement would result into various contracts at the start of 1999. This would be permitted by the EAF Agent. However, they avoided to include the FCPA representations and the audit rights until in 2003.
Recommendation-Brainstorming sessions and fraud related inquiries
Auditing is a complicated task and if proper care is not taken, many investors will continue to suffer. To avoid this, auditors are required to familiarize themselves with the current treads in audit practice. They should be up to date with the technology prevailing in the market to be in a position to deal with the current situations.
The AU (2010 sec.316 .para.14–17) explores how a well organized and effective audit team should conduct an audit work. One of the key issues in the AU section 316.14 article is the importance of having an audit plan. This goes hand in hand with making a reasonable examination of the probability of misstatements that may arise from fraud. It is important to ensure that team members exchanged ideas.
In other words, there is need for members of the auditing team to take part in brainstorming sessions regarding financial statements that are suspected to have been implicated with fraud. Also, the team should be at a fore front to consider how the management can engage in concealing the fraudulent financial reporting. Therefore, the discussion should be aimed at keeping the audit team awake and aware of how the fraud can be perpetrated and also concealed.
In addition, the importance of audit team members that have a questioning mind is clearly stressed out. The auditors should be aware of the reasons that encourage management to commit fraud. Also, the kind of the fraud to be perpetrated should be revolving in the minds of the auditors.
Further, an audit team needs to be hardworking and keen to details so as to obtain effective and appropriate evidences that would back up their judgments. The key members of the involved audit team must actively contribute in making decisions. This may be seen when the member is involved in brainstorming sessions and while evaluating the contract documents in efforts to check against fraud and misstatements.
The AU section 316.17 contains rules that affect the level of discussions that an audit team holds. It also controls how the discussion is carried out. In cases where more than one location is involved, the section suggests that team members hold various discussions in different locations for effectiveness. A case of this nature may involve a company and its subsidiary.
For an effective audit, it is advisable to be familiar with the planning steps which are very critical for an effective audit. There have been incidents like failure in observing the set standards. For instance, in the case where the PCAOB inspectors identified inspections that were carried out by an audit team who would not demonstrate the brainstorming session.
In the second instance, the PCAOB evaluators came across audits in which the audit teams did the brainstorming session after fieldwork had taken place. In the third case, the auditors identified audits that revealed that some key members were absent during the brainstorming session. Therefore, auditors and the management need to resume their respective duties of preventing and detecting errors once they arise.
Au section 110, (2010). Responsibility and functions of independent auditor. Web.
Apostolon, N., & Crumbley, L. (2009). Auditor’s responsibility with respect to fraud. The CPA Journal. USA: New York State Society of CPAs. Web.
Beasley, M. (2010). Fraudulent financial reporting. USA: North Calorina University. Web.
Pollick, M. (2010). What is fraud? USA: conjecture corporations. Web.
Shearman & Sterling LLP. (2009). Internal control failures lead to parent liability for a subsidiary’s FCPA violations. New York. Web.